For the purpose of understanding the importance of marginal costing system in the firm, let us start with the very fundamentals of marginal costing. Marginal costing is the system of ascertaining the marginal cost and its use for decision making. Marginal cost is the extra cost incurred for producing an additional output. The extra cost incurred usually is the one which is likely to change in direct proportion to the change in output. Such costs are known as variable cost and hence the costing system is also called variable costing system. The basic idea behind marginal costing system is that all variable costs are deducted from the sales to find out the contribution ( from which fixed expenses is later deducted to ascertain the profit) on the plea that fixed cost remains constant irrespective of the volume of output or sales. There are many applications of marginal costing in manufacturing concern. One of such applications is the decision with regard to the make or buy decision. In the make or buy decision, the management accountant undertakes a cost benefit analysis. Such a decision making requires the firm to know through marginal costing what contributes to fixed costs will result from a make decision. The points to be taken care of at the time of make or buy decision are:
When the capacity is available it cannot be utilized for manufacture of other products, then the purchase cost is compared with the marginal cost or total cost is compared with the purchase cost plus fixed cost of manufacture to take the decision to make or buy.
When the capacity is available and it can be utilized for manufacture of other products, the purchase price is compared with the marginal cost of the product and plus opportunity cost, i.e., the loss of contribution of other product replace
When there is no additional capacity available and it is proposed to acquire additional facilities for